Canada Had a Head Start with Cannabis. Has It Lost That Lead?

Canada was the first major economy in the world to legalize cannabis in 2018, giving it a headstart in establishing a competitive cannabis business marketplace.

But now some are saying the winds are shifting and the U.S. is catching up and becoming a more attractive place to build a cannabis business.

Part of this change has to do with criticism of investment practices in Canada.

Colorado-based pot brand house Cannabis One is one company that began with financing from an investment bank in Canada but has since walked away from that financing due to issues they found with practices in the Canadian marketplace.

CEO and founder Jeff Mascio said the bank “naked shorted” the company using insider information, which means the investment bank allegedly sold shares of Cannabis One it in fact did not have early, to reinvest the money back into the company.

Mascio explains that naked shorting is essentially counterfeiting shares and devalues the real shares the company introduces. He says it is illegal in the U.S., but it “happens all the time” in Canada.

Trouble brewing in Canada

The Globe reported that Bay Street insiders have been pouring money into the cannabis sector but have since sold their shares and moved on to other ventures — which is called short selling — leaving companies with no funding and without a business model to make the money they need to stay afloat.

In September, investment bank Mackie Research Capital Corp. said that nine companies would run out of cash in less than six months, according to its calculations.

Other signs of trouble for Canadian cannabis companies are popping up. In October, Canopy Growth Corp. and Aphria Inc. both sold stakes in Australian cannabis companies, and Hexo Corp. announced it is closing one of its greenhouses and laying off 200 staff.

Mascio has since moved where his company gets funding mainly to the U.S., with 80 per cent of its capital coming from U.S. markets and 20 per cent from Canadian public markets.

“Everybody is losing confidence in the equity markets in Canada,” he said. “[But] they’re also gaining confidence and availability of private equity, at least in the US.”

U.S. catching up

Mascio says that the investing situation has changed recently in the U.S.

More traditional private investors, such as high net worth individuals, are becoming increasingly comfortable investing in cannabis as federal legalization appears more and more likely after the Farm Bill in the U.S. last year made hemp-derived CBD production legal.

While Canada has had a headstart in developing its cannabis industry compared to the U.S., where cannabis is legal in some states but not federally, the latter still provides many opportunities that could see the country’s cannabis companies become industry leaders.

The sheer market size of the U.S. alone — a population of 300 million compared to Canada’s 30 million — makes it a vastly more valuable market.

“Canada’s going to go back to being irrelevant in the grand scheme of things,” Mascio said.

Scott Hammon, COO of New York-based cannabis investment and consultancy company MGO/Ello Alliance, says that valuations for cannabis companies have gone down in the U.S., which makes investors more willing to invest despite concerns over regulations. That is different from two years ago, when Hammon says there was no interest because investors couldn’t see how to make money.

While it is currently illegal for banks to do business with cannabis companies in the U.S., a new bill called the SAFE Act would change that and allow formal investment from banks. It has already been approved by the House of Representatives but still faces the Republican-held Senate.

Currently, U.S. stock exchanges won’t list cannabis-related companies with U.S. operations because the drug is still illegal federally.

As time goes on, social acceptance for cannabis has also increased, which makes investors feel like there is less risk in investing in the space.

If cannabis becomes legal federally in the U.S., then it will become like any other investment asset class, according to Hammon, and offers investors different approaches to the drug given it can be classified as a recreational product, similar to alcohol, or as a health and wellness or medicinal product.

“You’re just going to see a wider and broader class of investors that would come in if you see true legalization at the federal level in the US.,” he said.

Will cannabis be legalized in the U.S.? Mascio is willing to bet his business on it.

“You really in a sense can’t put the genie back in the bottle,” he said, pointing to the already large size of the cannabis market in the U.S.

Cross-border business

Even if the U.S. provides a better environment for cannabis business, does it really matter in this world of globalization, where companies can do business anywhere regardless of where they are based?

Hammon thinks it doesn’t as companies can do “cross border consolidation” in the industry, such as gaining investment or acquiring a company that has a low valuation but is in a different country. He points to the beer industry, where there have been multiple cross border mergers.

“In a world of globalization, or global commerce, the location or where a company is headquartered is probably become less and less relevant,” he said. “I think the [larger] Canadian companies recognize they need to grow outside their Canadian roots at some point.”

Already Canadian companies are doing just that. Recently the Globe reported Canopy Growth is lobbying Mexico’s government to allow foreign corporations to participate in its potential federal legalization of cannabis.

Canadian operator Aurora Cannabis told CNN that it will soon have a footprint in the U.S.’s CBD market, likely with a large acquisition.

Hammon says Canada’s market is limited by its size and the number of acquisitions that can be made in the country, leading many companies to look elsewhere for more flexibility and ability to scale more rapidly.

Ultimately, Hammon is hard-pressed to say any place that could dominate the industry globally, as it could happen anywhere.

Did Canada lose its headstart?

Canada will always lose in terms of market size when compared to the U.S., but even with cannabis still illegal federally in the U.S., some states may still be providing a better consumer experience than up north.

There are huge billboards for cannabis dispensaries, you can easily get weed delivered to your door the same day with services such as Eaze, CBD is available in grocery stores and edibles were already on dispensary shelves.

Compare that to Canada, where you may be hard-pressed to even find a legal dispensary, and even if you do, you are met with a sea of white labels that are not entirely consumer-friendly.

Did Canada screw up its headstart in the industry?

One cannabis professional that works with both U.S. and Canadian cannabis companies notes Canada’s mandate for cannabis was to keep it out of the hands of youth and fight the black market, and so the country took a conservative approach rather than bite off more than it could chew.

Shelley Madison is the Chief Creative Officer at Ronin, a cannabis content company that distributes content to big names like Amazon Prime and Google Play.

She says that cannabis legalization was a very complex undertaking as it could be used both recreationally and medicinally, and there wasn’t a clear model for it to follow.

To go nice and slow, the Canadian government chose to limit branding with strict rules that don’t allow companies to portray cannabis positively or associated with an exciting, glamourous or recreational lifestyle, which some, such as Mascio, have criticized as hindering businesses in the country.

Madison says though that companies are finding ways to work within Canada’s rules and still engage audiences.

“[Canadian companies] have had to sort of work outside of the box, so to speak, than some of the more traditional mass advertising means”, Madison said.

Some strategies include social purpose programming, such as Canopy Growth donating $2.5 million to the University of British Columbia to create the first professorship in cannabis science, with a focus on cannabis as a solution to the opioid epidemic.

That creates a positive story for cannabis outside of the usual mass marketing means, and Madison says consumers tend to be very interested in hearing these kinds of stories.

Madison also points out that while the laws may be looser in California, that is not necessarily representative of the U.S. in general, where some states still prohibit the drug. There’s no telling what the federal rules might be if cannabis is legalized across the country — they could even be stricter than Canada.

In the end, Madison thinks Canada is still leading the charge when it comes to cannabis.

“Canada is at the forefront of a movement that’s sweeping the world and is long overdue,” she said. “That’s really a really exciting place to be in.”